Risk, Rent, and Taxes

Dave SchulerApril 22, 2014

Of all of the thousands (maybe tens of thousands) of words I’ve read about income inequality in the aftermath of French economist Thomas Piketty’s visit to the United States, the article that resonated most with me has been Tyler Cowen’s review in Foreign Affairs of Dr. Piketty’s Capital in the Twenty-first Century. While acknowledging the significance of Dr. Piketty’s work:

Every now and then, the field of economics produces an important book; this is one of them. Thomas Piketty’s tome will put capitalist wealth back at the center of public debate, resurrect interest in the subject of wealth distribution, and revolutionize how people view the history of income inequality. On top of that, although the book’s prose (translated from the original French) might not qualify as scintillating, any educated person will be able to understand it — which sets the book apart from the vast majority of works by high-level economic theorists.

he finds it, as many commenters have, uneven. It, apparently, is better in vision than in policy prescriptions, in weaving a narrative that supports his views than fleshing out his ideas from a real world perspective.

Dr. Piketty, apparently, largely ignores the role of risk in capital returns. I think he can be forgiven for this because far too many of today’s risks aren’t risks at all. If you act with the reasonable expectation that the central government will step in to indemnify you against risks should your actions lose money, there is no risk.

Something that appears to have been ignored in the popular press is that Dr. Piketty’s concerns about income inequality aren’t focused solely on the ultra-rich, the Warren Buffetts or Bill Gateses, but also on petits rentiers, which includes most of the American professional class.

As I have emphasized here since the very origins of this blog, my greatest concern on this subject is how rent-seeking drives income inequality rather than on income inequality per se. Michael Jordan’s or Tiger Woods’s wealth do not concern me. The Kennedy family trust does. In a society as complex as ours with a government as pervasive as ours these rents take a vast number of forms—they encompass everything from royalty income to physicians’ wages to the subsidies received by bankers or GM executives and workers in the late recession. When you use the wealth you’ve gained through these rents to promote increases in your rents, as the late Sonny Bono manifestly did, it presents an assault on liberal democracy.

If your prescription for ending income inequality is, as Dr. Piketty’s, increased taxes on income and wealth, I challenge you to outline how this will work, recalling that when the highest marginal tax rate was over 90%, effective tax rates were little higher than they are now, i.e. marginal tax rates are virtually irrelevant to income inequality. Also, consider how many millionaires are sitting in the U. S. Congress. Does it actually seem likely to you that Congress will enact a tax on wealth? IMO a significant number of them are there to ensure that such a tax is never enacted into law.

I would be remiss in concluding this post without re-emphasizing that, at least as regards income inequality within the United States, reversing much of the income inequality that has come to pass over the period of the last forty years can be effected by controlling immigration, underwriting depositors rather than bankers, controlling healthcare costs, and emphasizing more jobs over other policy goals. It’s not your priorities that determine what you believe but your subpriorities.

I think that reinforces a point I’ve made for years now – that income inequality is bad everywhere, and getting worse, but its effects in Europe (as one example) are not as apparent because of the tax system.

It seems only natural that a French economist would see tax and redistribution as the best solution and, or some societies, it is. I don’t think the US is such a society however. We are a much less cohesive a society than France or Germany and, IMO, social cohesion is one of the critical elements necessary for collective action on the scale that Dr. Piketty advocates. Cohesion in the US is, arguably, in retreat which will make it even more difficult to enact any national level policy (not just increased taxes) that does more than nibble at the margins.

To be honest, what’s needed is a way to put money in its place. To me, heavily taxing people who have devoted their lives to accumulating an enormous amount of money, through the wonders of Apple or Amazon or like poor Mitt Romney, Staples, is a start.

Overall, what’s baleful about Marx is his reductionism, not his dire vision. Not everything associated with making a profit becomes ground into the sole need for profit. You can start a business that serves a purpose or gives pleasure or delight, you can turn a profit, and you can negotiate with employees without becoming some lunatic who thinks about right-sizing and how to serve on boards and pay yourself 833 million a day in stock options (though you probably deserve more). Or like Jeff Bezos, pick a thing to sell, books, a thing that millions of people love, simply because it serves your business model the best.

Taxation was never a particularly effective method of preventing over-accumulation, although the estate tax was a significant factor. It’s just too easy to write loopholes into the tax code, which was happening by the end of the first Eisenhower Administration. Picketty’s suggestion of a global tax is ludicrous as it would be impossible to enforce, let alone actually get everyone to legislate it.

High inequality is entirely a result of dysfunctional corporate governance and the dominant role played by capital markets over the real economy. We a dress the problem there or we shouldn’t bother at all.

I agree with just about everything in that comment, Ben. Bad corporate governance is an extremely serious problem. I think it’s time to reform and extend the Clayton Act.

One of the many things that puzzle me is the number of small government types who don’t recognize that all sorts of things they take for granted, e.g. inheritance and intellectual property, are impossible except in the context of a robust state.

“High inequality is entirely a result of dysfunctional corporate governance and the dominant role played by capital markets over the real economy.”

How, to each one?

“I think it’s time to reform and extend the Clayton Act.”

I can imagine that eliminating duel board participation would deal with corporate governance issues, but that’s it. And monopoly or anti-competitive issues seem more ones of enforcement (as opposed to law) than anything else………….selective enforcement by a powerful government and captured regulatory apparatus that is.

Among other things the Clayton Act prohibits “interlocking directorates”. I think that needs to be extended to eliminate other, related strategies. Your example of “dual board participation” is one of them.

Uneven sounds about right to me if you are writing on inequality. The first step is to acknowledge that it is real, and that it is a problem. Way too many people are in denial on this topic. If the book accomplishes this alone, it is a great book. The solution is not obvious. Ben has it mostly right I think and I have no idea how we change that kind of culture. As I have said before, I think we might be past a tipping point. The wealthy have gotten better at controlling the media and our politics. In the 30s, they didnt know how to do this yet. After destroying the economy of the world, they got hurt. After this round, they got bailed out and are becoming richer than ever.

As Marx has been brought up, does it look like one of his critiques of capitalism is holding up. In end stage capitalism do have our wealth concentrated into a small group of wealthy and the rest of us are peasants? Are we on the road to serfdom?

Chief executives are no longer tied to the long term success of the companies they manage and the people they employ. The most glaring example of this is that executive compensation now primarily consists of stocks, stock options and bonuses fixed to stock performance, firmly wedding their personal incomes to the approval of Wall Street traders.

We can see this in the bull market of the last four years, which has been almost entirely driven by corporate stock purchases to boost prices, by definition a non-productive function. It doesn’t increase capacity or develop new products, but it does make the stock market happy.

Look at HP: CEO after CEO has slashed the workforce and enacted rather savage cuts to R&D since the financial crash, with one of the results being caught flat-footed by the iPad and requiring two full years to develop a competing product. But to CEOs, many of whom now jump from corporation to corporation, it isn’t relevant because they aren’t being paid to compete with Apple, they’re being paid to pump equities. Pick a company and you’ll more often than not see a CEO who has no real familiarity with how it works, but they are great financial salesmen.

This results in what Bill Black has termed a “Gresham’s Dynamic”, where this sort of counterproductive behavior generates perverse incentives and actually drives the “good” behavior out of a market for fear of failing to remain competitive with the salaries of other executives.